When submitting tax returns, the IRS and many other taxing authorities allow a taxpayer to apply various adjustments, or subtractions, to the taxpayer's gross income. The applicable adjustments depend upon the taxpayer's filing status and the tax form that the taxpayer files. The applicable amounts are subtracted from the taxpayer's gross income to determine an adjusted gross income (“AGI”). AGI represents the taxpayer's gross income reduced by the applicable adjustments.
For a U.S. taxpayer paying taxes under the U.S. Tax Code, AGI may be reduced by taking various deductions that the IRS allows the taxpayer to subtract from his or her income. A standard dollar amount for each of five filing categories may be applied. A taxpayer has the option of using the preset, standard dollar amount or, if the taxpayer has tax-allowable expenses (such as mortgage interest, charitable contributions, large medical expenses) that are greater than the standard deduction amount, the amount of the expenses. To take advantage of the expenses, a taxpayer uses an IRS Form 1040 and itemizes the deductions on Schedule A. The Schedule A amount is then subtracted from the taxpayer's AGI.
The IRS also permits taxpayers to reduce income by using exemptions. Exemptions are provided for people who depend upon the taxpayer for financial support, such as a spouse, children, in some cases parents, and the taxpayer. The IRS allows the taxpayer to multiply the applicable number of people by a dollar amount (adjusted for inflation annually) and then subtract it from the taxpayer's income.
Finally, the IRS allows taxpayers to reduce their tax liability by applying credits to the amount of taxes owed. Under the U.S. Tax Code, certain taxpayers may be eligible for tax credits related to child care or adoption.
After the deductions and exemptions are applied to the taxpayer's income, the taxpayer's taxable income is determined. This amount is used to determine the taxpayer's tax bill. Tax credits may be applied to the taxpayer's tax liability. Therefore, it is beneficial to taxpayers to take all permissible deductions, exemptions, and credits to reduce their taxable incomes and therefore, their tax liabilities. However, determining which adjustments apply to a taxpayer can be difficult and time consuming. More importantly, in many instances, a taxpayer may further benefit from certain actions that would allow him or her to qualify for additional adjustments to reduce taxable income. Analyzing a taxpayer's situation to determine whether the taxpayer may take certain actions to qualify for additional adjustments requires the ability to examine outcomes or results as the taxpayer's situation is varied.
Current methods of computing a taxpayer's benefits from reduction of AGI are often completed by hand using various IRS tax forms. However, this process of using manual calculations is slow and imprecise. It is often too time-consuming to cover various scenarios. A taxpayer who uses some personal tax preparation software (i.e., software used by a taxpayer who prefers to prepare his or her own tax return) may be able to determine the tax-savings impact of an AGI change on his or her deductions, exemptions, and credits. However, to make this determination, the taxpayer must actually change a specific adjustment amount he or she entered so that the software can recalculate the entire return. Physically changing multiple entries in a tax software program is cumbersome, as the taxpayer must work back and forth among all available adjustments to determine the best possible outcome. Furthermore, it may lead to preparation of an inaccurate tax return if the provisional entries are not returned to the actual amounts applicable to the taxpayer's situation. Finally, neither method allows a professional tax return preparer and a taxpayer client to review together each potential adjustment. Therefore, there is a need for a general-purpose tool that assists multiple taxpayers in capitalizing on valid tax savings opportunities.